GATX Corporation

Good day, and welcome to the GATX 2021 third quarter conference call. Today's conference is being recorded. At this time, I would like to turn the conference over to Sherry Hellerman, Director of Investor Relations. Please go ahead, ma'am.

Thank you, David. Good morning, everyone, and thank you for joining GATX's 2021 third quarter earnings call. I'm joined today by Brian Kenney, President and CEO of Tom Ellman, Executive Vice President and CFO, and Bob Lyons, Executive Vice President and President of Rail North America. Please note that some of the information you'll hear during our discussion today will consist of forward-looking statements. Actual results or trends could differ materially from those statements or forecasts. For more information, please refer to the risk factors included in our earnings release and those discussed in GATX's Form 10-K for 2020. GATX assumes no obligation to update or revise any forward-looking statements to reflect subsequent events or circumstances. Earlier today, GATX reported 2021 third quarter net income from continuing operations of $40.1 million, or $1.11 per Duluth share. This compares to 2020 third quarter net income from continuing operations of $48.2 million, or $1.36 per diluted share. Year-to-date 2021 net income from continuing operations was $82.1 million or $2.28 per diluted share. This compares to $132.4 million or $3.74 per diluted share for the same period in 2020. The 2021 year-to-date results include a net negative impact of $39.7 million or $1.10 per diluted share related to an enacted tax rate increase in the United Kingdom and a net negative impact of $3.4 million or $0.09 per diluted share attributed to debt extinguishment costs associated with an early redemption. The 2020 third quarter and year-to-date results include a net negative impact of $12.3 million or $0.35 per diluted share related to the elimination of a previously announced tax rate reduction in the United Kingdom. These items are detailed on page 12 of our earnings release. Now, I'll briefly address each segment. The operating environment for Rail North America continued to steadily improve in the third quarter. Rail North America's fleet utilization increased to 99.2% at quarter end, and our renewal success rate was 84%. reflective of the strong execution by our commercial team, as well as gradually improving demand for most car types. For the fifth quarter in a row, absolute lease rates increased from the prior quarter. The third quarter renewal rate change of GATX's lease price index was negative 8.1%, with an average renewal term of 32 months. We continue to successfully place new railcars from our committed supply agreements with a diverse customer base. We've placed our 8,950 railcars from our 2014 Trinity Supply Agreement and over 2,800 railcars from our 2018 Trinity Supply Agreement. Additionally, we've placed over 6,100 railcars from our 2018 Greenbrier Supply Agreement. Our earliest available scheduled delivery under our supply agreement It's in the second quarter of 2022. The secondary market for rail cars remains active. Rail North America's third quarter remarketing income was $14.6 million, bringing total remarketing income for the year to $63 million. Within Rail International, both GATX Rail Europe and GATX Rail India maintain high fleet utilization at quarter end, as demand for rail cars remain robust. Rail International's investment volume was approximately $41 million during the quarter, as we continue to take delivery of new cars and grow our fleets in Europe and India. However, the pace of fleet growth in both regions this year has been negatively impacted by COVID-19-related delays at rail car manufacturers. The portfolio management segment is performing as expected. The Rolls-Royce and Partners Finance affiliates continue to operate in a challenging environment, as global air passenger volumes remain significantly below 2019 levels. Finally, as noted in the release, we continue to expect 2021 full-year earnings to be in the range of $430 to $450 per diluted share, excluding any impacts from tax adjustments and other items. And those are our prepared remarks. I'll hand it back to David so we can open it up for Q&A.

Thank you. If you would like to ask a question, please signal by pressing star 1 on your telephone keypad. If you're using a speakerphone, please make sure your mute function is turned off to allow your signal to reach our equipment. Again, press star 1 to ask a question. We'll pause for just a moment to allow everyone an opportunity to signal for questions.

We'll take our first question from Allison Poliniak with Wells Fargo.

Hey, good morning. A question around the lease portfolio. You know, obviously lease rates are trending in the right direction, but is there any, you know, is there a way to kind of quantify what percent of your fleet is still struggling with some of the overcapacity or just lagging recovery issues there in terms of like what's below and what's, you know, kind of above where you think you should be at this point?

Good morning, Allison. It's Bob Lyons. I'll take that one. You know, as Sherry referenced, for the fifth quarter in a row, we had sequential lease rates improve. You know, on a fleet-wide basis, probably in the mid-single-digit range, tank a little bit better in the third quarter than freight. But in general, things moving in the right direction. I think, as you know, our fleet is very, very highly diversified. So we're not skewed to any one particular card type. Some of the more challenged card types continue to be the culprits we've talked about in the past, whether it be coal or small cube covered hoppers. And quite frankly, our exposure there is low. So as we march forward and the market continues to improve, which it is, Yeah, we'll take full advantage of that and we'll see the opportunity to turn more of our fleet into positive territory.

Thanks. And then just, you guys have always put out that indicator of the relationship between velocity and, you know, rail cars. You know, is there, you know, being added to sort of the network, you know, given the challenges, you know, is that something we should be mindful of or is there something different in this environment that maybe that correlation doesn't hold true, you know, into 2022?

Well, I think with all the global supply chain issues, some correlations are being broken all over the map. But in general, yeah, lower velocity tends to cause an uptick in the need to move a fixed amount of freight. So that said, you know, the fact that the class ones are still somewhat velocity challenged a little bit better in the third quarter than the second, but Still challenged on that front. Yeah, that does cause some uptick in demand. What I would say is that tends to be relatively short-term, and what we want overall is for the railroads to operate at a very efficient level, so that is the mode of choice for our customers. If there's significant congestion, significant problems, yeah, it can cause an uptick in demand for cars, but that tends to be short-lived.

Got it. And then just the last, oh, sorry, go ahead.

Yeah, I was just going to say the rule of thumb I think you're referring to was the old one mile per hour is about 50,000 cars. But the really important thing to note there is that is going to impact car types that move in unit train service more than car types that move in manifest service, which is the bulk of GATX's fleet. So if you're thinking in terms of a return to normal, the tank cars and the specialty-covered hoppers that make less trips would be impacted less by that than car types like intermodal that are much more active on the rail lines.

Got it. That's helpful. And then just one last question. On the rail pulse JV that GATX has entered, you hear a lot of folks rethinking supply chain just given some of the challenges. Any update in terms of where you are with that JV at this point?

Sure. Well, we're encouraged by the involvement from our partners. As you know, there's five of us that were the seed partners in Rail Pulse, ourselves, Norfolk Southern, G&W, Trinity, and Watco. And we're definitely, as I said, encouraged by the progress made today. We're heavily involved in identifying the right tech platform and infrastructure to use. broadly between the five of us to continue to gather all the information, the data, the telematics output that we plan to get from the joint venture. Funding continues ongoing, and we have a lot of interest from other potential parties. The five of us control about 20% of the North American fleet, and there are others who are very interested in joining the group. Good dialogue there, but it will take a little bit of time here, Alison, to really get the platform in place and get the infrastructure in place to get the partnership up and running.

Understood. I'll pass it along. Thanks.

We'll take our next question from Justin Long with Stevens.

Thanks, and good morning. I wanted to start with the question on the guidance. I know the outlook from an EPS perspective didn't change for 2021, but any moving pieces within the guidance that have changed versus what you expected a quarter ago? And then maybe specifically on North American remarketing, it seems like we're headed for a record year potentially. What's your confidence in the sustainability of this strength as we get into 2022?

Yeah, so first of all, in terms of the guidance, you'll recall when we went through that, what we talked about was a series of areas where the guidance, where our beginning of year range was at the positive end of the guidance. So lease rate improvement was what we expected, but at the high end of the range. Maintenance expense was what we expected, but at the lower end of the range. I would say that that largely has continued, and across the board, I wouldn't point to significant variances between our expectations last quarter and this quarter, hence the unchanged guidance. When you specifically talk about the asset disposition gains, the market remains very strong. When we put out a package, we get a broad response to it, a lot of people interested in buying. We expect that to continue. When you talk about the absolute timing of those gains, as we've discussed before, it's really hard to pinpoint those to a given quarter. But in general, is it our expectations that a strong remarketing environment would continue into 2022? I would say yes.

Yeah, and Justin, I would add too, we laid out at the beginning of the year back in January that we anticipated this year would be a very strong year and near record levels for remarketing income. So as you know, we're on track to do that. And as Tom mentioned, the fundamentals that underpin that remain in place and look like they'll continue to be that case going into 2022.

Okay, that's helpful. And secondly, I wanted to ask if there have been any notable changes in the pipeline of investment opportunities as you look across the different businesses and geographies. Are you still confident that you can continue to deploy capital at an elevated level as we've seen coming out of this pandemic? Or I know we haven't been active on buybacks in a while. Is that something that might be moving up the priority list? Yes.

Justin, it's Brian. That's a great and timely question because, you know, I don't want to be too repetitive on our capital allocation, but you know there's three priorities. One's investing in the business. Second is ensuring the access to capital. And third is returning that access capital to shareholders for your question. So on the investing side, very successful this year finding investments across our businesses. Trifleet at the beginning of the year, direct engine investment. and some great organic rail opportunities really across our rail market. So we do anticipate that we'll invest over a billion dollars again in 2021. That's pretty good in a market that has been weakened by COVID. But as far as priority three and return of capital, obviously we have the dividend for over 100 years and we have the existing share repurchase authority. And I can assure you Sherry Purchase is still on the table. And I think we've proven the willingness to return that capital that way over the last 15 years. But if it helps you understand where we are right now, given the run-up in new asset prices really across our businesses this year, I think we're approaching an inflection point where it's getting more difficult to economically justify a new speculative investment. So if these asset prices continue, the likelihood of share repurchase becomes greater. I mean, that's always been the way our investment model and our investment philosophy work. So stay tuned. Obviously, we're going to evaluate the opportunities for both, but the scales are starting to tip given the run-up in asset prices.

Great.

Very helpful. I appreciate it, Brian.

We'll take our next question from Matt Elcott with Cowan.

Good morning. Thank you for taking my question. It's good to see the fifth consecutive spot. Absolutely sweet improvement. I think in 3Q it was in the high single digits. I mean, in 2Q it was in the high single digits up from mid-single digits before that. Sorry if I missed it, but did you guys quantify the magnitude in the third quarter?

Yeah, man, I said it was mid-single digits. And again, there's elements of... mix that come into play in that for sure. So it's not linear.

Okay. Got it. But the, you know, apparent deceleration is not indicative of any type of demand pullback.

No, not at all. And I would say the, you know, the basic tenets of what we expected to be, you know, a gradual recovery in our market absolutely remain in place. And as we look forward, that continues to be the case.

Okay. And then I just want to go back to the, you know, broader high-level investment front. You know, India, you have a very small fleet there, but it's been a promising market. I think India is coming off of some couple of rough years. 2019 was a broader economic pullback on the election and then 2020 COVID. And now they have a $1.4 trillion infrastructure bill. Are you seeing opportunities to further grow the fleet in India meaningfully?

Yeah, it's Brian. I can take that. Yes, we do. And if you just look at what's committed with our manufacturers and placed with customers right now, we'll grow the fleet by 27% over the next year or so. So, yeah, there are some strong investment opportunities. We've already wrapped them up. And the macro environment's improving. Obviously, they were shut down earlier this year due to COVID, but that situation has significantly improved. As you said, our management team in India would say conditions are approaching normal. Remember, it doesn't really impact their results because their fleet's 100% utilized. They have long-term leases. But it did shut down the rail manufacturers for a period. So investment is lower than we anticipated coming into the year in India. mostly due to COVID delays and some customer growth conversations got stalled as well in the face of COVID. But with the macro environment improving, strong GDP growth, you know, interest rates are reasonable. We're seeing a recovery in traffic, freight traffic, container traffic. So it's coming back nicely and the opportunities are there.

Okay, that makes sense. And on the investment front in North America, you know that share repurchases may be, you know, looking a bit more compelling in the future if valuations continue to be elevated. But are you are you guys flexible to consider non railcar assets in North America, maybe, you know, assets with strong service components like highway tankers or other types of assets?

Yeah, I think you, I mean, our Tricely acquisition wasn't in North America, but that's an example. If we see a long-lived, widely used asset with a service component and we like the business, we'll be willing to extend away from rail. I don't see that right now in North America, but we're willing to consider it, yes.

Got it. Thank you very much. We'll take our next question from Bascom Majors with Susquehanna.

Yeah, thanks for taking my question. Can you drill down into the RRPF, JV? What drove the sequential delta in your income pickup there? Any thoughts on whether the renewal situation has stabilized and what that looks like as far as a headwind into 2022? Thank you.

In RRPF, we mentioned coming into the year that that was the part of our portfolio of businesses that that was the most difficult to accurately predict what was going to happen going on throughout the course of the year. When we came into the year, we noted that we expected earnings from that JV to be down $40 million or more. And year-to-date pre-tax earnings are $26 million versus about $93 million last year. for the year-to-date period. Now, it's important to note that last year had a unique transaction that we discussed, which was where we sold a group of engines to third-party investors that had been put on a long-term lease with Rolls-Royce, who were using them to support the total care program. That unique transaction contributed about $32 million to our pre-tax share of affiliate earnings. So if you look at The total decrease, year-to-date versus year-to-date, it's a $67 million increase. About $32 million of it was due to that unique transaction. Another, and the remainder of it, is about one-third due to changes in the operating business, which is the number of engines on lease, the rates that were earning for them, the bad debt expense, and about two-thirds of it is due to other secondary market transactions.

As far as how to feel about that business going forward, has the value and lease rates stabilized at all in the market? Just trying to think about what that degree of uncertainty feels like today versus six, nine months ago when you laid out that guidance and noted, you know, that it could move in a couple of different directions.

Yes, so I would say overall we continue to focus on that same guidance, which was the $40 million or more down. In terms of what's happened, you know, we've been collecting about 83% of the monthly billing that we expected to coming in, so cash collections are going largely as expected. We've been able to earn some money on the asset disposition. So largely things continue as we expected. Obviously this is a business that is going to take some time to fully recover, but the trajectory is in line with our expectations coming into the year.

And lastly, you made the comments earlier pretty transparently that asset values were making acquisitive investment pretty challenging. Did that include potential additional deals and like the direct investments you did in aircraft engines or maybe expanding the tri-fleet platform? Just any thoughts on some of these non-rail assets and if those valuations are getting to the point where your stock's starting to look pretty attractive? Thanks.

Yeah, so on Tri-Fleet, another good example. I mean, new asset prices there are increasing for the same reasons they're increasing in rail, which is steel costs and component costs and manufacturer backlog. So, you know, looking as an example at a standard container, tank container at Tri-Fleet, it's 50% more expensive recently than it was for the same tank at the beginning of the year. So, you know, really across the businesses, new asset purchases or speculative purchases are getting more difficult to justify. And I don't think there's any exception, but I'll let Tom talk about aircraft values.

Yeah, so we're a counter-cyclical investor. So we certainly look for those types of opportunities. That's what happened in the first quarter when we were able to make those investment in engines for our own account, which are continuing, which like the joint venture engines are managed by our joint venture partner. We'll continue to be on the lookout for those. As a reminder, those were the best engine types on lease to the best credits, and we'll continue to look for that kind of investment. It's difficult to predict exactly how much of that is available.

Right, but I think it's safe to say that airline spreads have come in pretty dramatically from their peak, which is when we did that investment earlier in the year.

I'll just add with regards to North American Rail. I do just want to point out that, you know, as you know, we generate investment volume there through a number of different channels, primarily through our supply agreement. But we also see opportunities outside of the supply agreement to do investments that are basically done in conjunction with a long-term lease with a customer. We're going to have a really solid year on that front. You know, we were successful on a number of transactions, winning a number of transactions. But you have to be very selective about the car type of the underlying customer. And as Brian mentioned, with rising asset prices, you need to price them accordingly. So we've been successful in winning some of that business. And we've also taken a pass on some because The asset price and the rates haven't made sense.

Another great example I'd like to see Tom talk about is we've been through this drill before with very high asset prices. It pushes you to different types of investments. Actually, Tom did the boxcar acquisition a few years ago.

Back in 2014, one of the things that we really looked at, given that asset prices overall were high, was what's an asset type that we find attractive that others maybe not as much would recognize that value. And in particular, we purchased the boxcar portfolio from GE. Those assets were largely on per diem leases as opposed to fixed rate leases, which was something some of our competitors really didn't have the infrastructure in place to handle. So we were able to buy those assets at twice scrap value, so very attractive prices. and then largely convert them relatively quickly, for the most part, to fixed-rate leases and earn a nice return on an asset class that others were overlooking. So that's the kind of thing we try to do when asset prices are a little bit higher.

Thanks to everyone for the answer there.

I really appreciate it. We'll take our next question from Justin Bergner with Gabelli Funds.

Good morning, Brian. Good morning, Bob. Good morning, Tom. Good morning, Sherry. Good morning. Just first off, maybe following up on the Rolls-Royce joint venture, is that $4 million of affiliate income sort of a number that would represent income sort of X amount portfolio gains on sale, or is there actually something unusual in terms of maybe losses and disposition or something else that's weighing down that number?

Yeah, so Justin, that includes all the earnings from our share of the earnings from the joint venture, and it includes both earnings from operations, the leasing of engines, as well as in remarketing, where we sell an engine at the end of its life or part it out or something along those lines. So it includes both.

Okay. But, I mean, is there anything you can speak to that's unusual that would have weighed down that number in the quarter?

Yeah. So compared to the first half of the year, both the – operating income line and the remarketing line are down versus the first half of the year. That remarketing line is regularly inconsistent. The chance to either part out engines or sell them to a third party, that happens in a lumpy fashion. So I wouldn't really read anything in particular into that. From the operating income perspective, there's two things that are driving that number down a bit. One is we've been selling some engines, so each quarter you have a few less engines that are earning revenue, so that's going to tend to take that operating income line down. The second of which is some of the challenges for the airlines. When an airline has an issue, we reserve for all the receivables there, so bad debt expense is elevated.

Great. That's actually very helpful. Thank you. With respect to the LPI, are you able to sort of speak to what factors may have caused that to sort of nudge down? Was that just sort of a mixed impact? A lot of the cars that were new were some of the weaker car types in the quarter? Or is there anything that you can just say to provide a little perspective there?

Sure, Justin, it's Bob. And again, like a lot of the metrics we've talked about today, whether it's remarketing income or sequential lease rates, the LPI, nothing's really linear in our business. When I look at the LPI for the third quarter, while the LPI is designed to try to take as much mix out of the equation as possible, there are occasionally some renewals that can skew the outcome. And in the third quarter, we had a few renewals that were coming off extremely high rates that were put on back in 2015, 2016, and a couple of challenged car types. The good news is there, those customers renewed all of those cars, but did so at a market rate. And so they had an outsized impact on the LPI. But for those few transactions, the LPI would have been closer to break-even in the third quarter.

Okay, that's helpful. Thank you. Maybe lastly, just on the question of investment opportunities, I guess one of your competitors recently made an investment in a fleet of rail cars, seemingly like an older fleet of rail cars, and you referred to the boxcar investment, and then I guess the Andersons portfolio was sold. I mean, are there any opportunities to sort of buy older cars at a couple times scrap value like you did with the boxcar transaction a number of years back, or is that something you would do very selectively in a car type? as you mentioned, that you had a different view versus your peers?

Well, one of the things that was unique about the boxcar transaction was that it was a transaction of size, a lot of assets, a lot of cars in a particular car type that could be carved out, was carved out from GE. That doesn't really exist in other portfolios that we look at. We look at all the Almost all the transactions that occur in the secondary market, the ones you referenced, we're familiar with all of those. We have a voracious appetite for quality assets at the right price. And so we do look at everything. Nothing has changed hands this past year that would have worked for GATX or been attractive from a portfolio quality standpoint at all. And certainly not at the valuations they went off at.

Yeah, and that... transaction you're specifically referring to, a lot of those cars in that fleet came from GATX, selling them to the Andersons. And for that reason, I think significant M&A in rural North America is fairly unlikely in the current environment. And that's mostly due to the fact that the larger portfolios that may come up for sale are likely to be of lower quality, but they're still going to seek the high prices that are out there. probably not willing to pay.

Okay, understood. Thank you. Just quickly, could you just remind us what the guidance for the gain on asset dispositions in North America was, I guess, as last updated?

I think we came into the year saying that we would be at a record level, which was in probably the $75 to $80 million, $75 million range. You know, year-to-date, we're in the low 60s, so that guidance is still old.

Great. Thank you. Once again, if you would like to ask a question, please press star 1. We have no more questions in the queue.

Sherry Hellerman, at this time, I will turn the conference back to you for any additional or closing remarks.

I'd like to thank everyone for their participation on the call this morning. Please contact me with any follow-up questions. Thank you.

This concludes today's call. Thank you for your participation. You may now disconnect.